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Monthly Archives: November 2014

The peoples of this planet desire both peace and order, but we have become gridlocked in our thinking about how to achieve this: The European and North American nations have simply assumed that the world would naturally adopt westernization as the way forward; Islam has been locked for over a thousand years in its faith that the Koran is the only way for global unity and peace; and the Chinese have traditionally viewed themselves at the center of civilization. How to proceed? The outspoken Indian writer, Pankaj Mishra, has observed that many now doubt “that western institutions of the nation state and liberal democracy will be gradually generalized around the world, and that the aspiring middle classes created by industrial capitalism will bring about accountable, representative and stable government. In short, that every society is destined to evolve just as the west did.”1

The evaluation of this educated scholar demands a careful examination of both how the current state of global disorder has come about and why “westernization” is not necessarily the answer. Many nations are still eager to catch up with the living standards of the more advanced states in Europe and North America and peoples of divergent cultures are being swayed by the external pressures to make them conform to an alien socio-economic outlook.

Can states like Nigeria, Myanmar, Pakistan or Thailand overcome the inner contradictions incorporated in nationalism, democracy, globalization, and economic instability? Its populations do not accept the driving force of western “rules” for the world, namely market capitalism, with its impact and outlook on time, speed, way of life, as well as on work, energy and pollution of the environment. They see this economic system being imposed on them as very much at odds with their local as well as traditional social and political structures. Some also fear that the era of rapid growth may now be at an end and that consequently they may be on the edge of a descent into chaos.

Even members of the more “advanced” societies find it difficult to accept that our “humanism” and civilization have been founded on the back of centuries of wars, conquests, slavery and the exploitation of peoples and resources. There is concern that, with its emphasis on human rights, as well as on equality and democracy, “westernization” cannot be something that can be exported effectively with swift results. Cultural and political concepts such as legal frameworks, rationality, democracy, constitutions and legitimacy, when combined with economic forces such as increasingly freer trade, have taken centuries to develop.

The United States, ever since its inception, has been at the forefront of spreading democratic principles. With great insight, the fathers of the American Revolution instituted the separation of church and state. From the first, Americans believed the world would progress if it could follow or emulate its example. Theodore Roosevelt was the first President to deal systematically with both the responsibilities and implications of America’s increasing world role. He declared that when it came to interference in Latin America: “All that this country desires is to see the neighboring countries stable, orderly and prosperous.”

Woodrow Wilson went further in expressing this desire when declaring war against Germany in 1917, saying: “We have no selfish ends to serve. We desire no conquest, no dominion … We are but one of the champions of the rights of mankind.” President Wilson’s outlook was in tune with the aspirations of an electorate of diverse migrants eager to spread democracy beyond its borders. Since the end of WWII, Presidents have insisted that the United States had global interests while most other countries merely had national interests. Former Secretary of State Henry Kissinger, in his latest book World Order, defined the “American Consensus” as “an inexorably expanding cooperative order of states observing common rules and norms, embracing liberal economic systems … and adopting participatory and democratic systems of government.”2

Such a position is diametrically opposed to that of the Muslim world. There is no “Islamic Consensus,” just an obligation binding on every Muslim to expand his faith through struggle by means of “his heart, his tongue, his hands, or by the sword.”3 This is now known globally as “Jihad.” The Muslim approach by-passes that of most western leaders and politicians seeking pragmatic and rational solutions as an alternative to conflict. Islam’s universal vision is that the overthrow of “foreign legitimacy” (that is, western legal, political and economic practices) is mandatory. The incompatibility of the western forms of international order with the ruthlessness of Jihad has been recognized by Europeans for over a thousand years.

In Islam’s universal concept of world order, which has hardly evolved over the past thousand years, a single divinely sanctioned governance rules and unites all parties that have either accepted the Koran or have been forced into submission.* Sultan Mehmed the Conqueror, who proclaimed his people as “the shadow of God on earth,” was to declare in the 15th Century that “There must be only one empire, one faith, and one sovereignty in the world.” This dictum remains in Muslim hearts to this day. Even the brutal leaders of Isis and al-Qaeda believe that what the Koran prescribed in the building of the social order has been historically tested and is therefore valid and will ultimately bring Islamic unity. How the bitterly divisive struggle between Shias and Sunnis, which has raged for 1,300 years, can be resolved into a united faith remains unclear.

The Post WWI creation of European style secular states in the Middle East, such as Egypt, Iraq, Jordan, Lebanon, Palestine, Turkey and Saudi Arabia, by French and English cartographers, civil servants and politicians was a blue-print for trouble. The leaders of certain tribal factions used the concepts of statehood and sovereignty imposed on them for their own ends. While the “Pan Arabists” continued to view the region as a single linguistic and cultural entity, such as it had been under the Ottoman Empire, the political Islamists saw their common religion as the best way forward in creating a modern Arab identity without having to abandon their historic cultural values, that is, without becoming westernized.

Towards the end of the 20th Century, the excesses and failures of the secular rulers in Iraq, Syria and Egypt led to a more religiously inspired governance backed by opportunistic terrorism for those seeking to fulfill their own universal mission. Groups like Hamas, al Qaeda, Isis, and Hezbollah all regarded the nation state as a secular institution and thus illegitimate. The United States and other western powers tried to hold the artificially created nation of Iraq together when it was really a number of different groupings of Kurds, Shias, Sunnis and others who regarded each other with open hostility.

Christendom, by comparison, has never become a strategy for imposing international order. Christians have made a clear distinction between what is Caesar’s and what is God’s. This has enabled the evolution towards a secular, pluralistic nation-based international system. Kissinger’s endorsement of the Westphalian system of the balance of power between nation states was based on their acceptance as being legitimate units in search of a common creation of order.

Other societies, such as that of China, never historically engaged in the creation of order with other nations. For millennia the Chinese inhabited their own ordered world surrounded by ”barbarians” whom they disdainfully dismissed. To this day China does not accept the proposition that international order is fostered by the spread of democracy or human rights. They firmly believe that any international effort towards a balance of power must be combined with the concept of partnership. Order and freedom have yet to be understood by them as interdependent in a pluralistic world.

Our era is intensely pursuing a working concept of a world order (which thus far has been no more than a phantom). National interests have to gradually accept second place to universal interests in such areas as the environment, economic stability, and the long-term future. But it is hard for new nations like India, Indonesia and South Africa to maintain an internal political consensus when faced with privatization of their water and energy as well as the exploitation of their land and mineral resources by foreign companies. Western prescriptions for what is ailing their societies are not appealing.

The EU has already made some progress in transcending narrow national interests through a structure of pooled sovereignty. The EU as well as the English-speaking world have been striving to curtail mounting international chaos by creating a network of international economic, legal and organizational structures dealing with free trade and market capitalism. However, unstable economics now dominate the world, not religion, science, technology, ideology, morals nor even rationality. As two outspoken editors of The Economist warn in their latest book4 the western way is in danger of being left behind. They suggest that it is unclear which political values will triumph in the 21st Century. The battle is between the liberal values of democracy and freedom versus the authoritarian power of command and control.

Indeed, where has western progress led us? It has forced billions off the land into stiflingly overcrowded cities; it is producing such levels of pollution that survival itself has come into question; it is robbing the land and the seas of its resources; and it has produced a scientific and technological revolution which may be separating mankind from its humanity.

Widening voter disaffection in the US, the UK, France, Italy and most democracies reveals that the realities of our disordered world do not match the ideals of yesteryear. Pankaj Mishra claims that “The time for grand Hegelian theories about the rational spirit of history incarnated in the nation-state, socialism, capitalism or liberal democracy is now over.”5 Indeed current political leadership in the western world seems unable to tackle their rapidly growing economic inequalities, the millions of young people without employment and the vanishing prospects of continued growth.

The nations of the world have yet to accept that a long-term strategy based on careful consideration of the needs as well as the prospects of all its inhabitants is essential. We must begin to understand where we want such strategy to lead us and how it could meet humanity’s basic aspirations.

1Pankaj Mishra, “Once Upon a time in the West,” The Guardian, October 14, 2014.2Henry Kissinger, World Order, 2014, p.13Majid Khadduri, War and Peace in the Law of Islam, (1955) p.564John Micklethwait and Adrian Wooldridge, The Fourth Revolution, 2014.5op.cit. Mishra*Note: “The first deliberate attempt in history to unite heterogeneous African, Asian and European communities into a single organized international society” was formulated by the Persian Kings in the 6th Century BC. (Kissinger. op cit., p.5)

Human beings want to know where they stand in relationship to others. Being first is important. Capitalist competition pushes the desire of many egos to be #1. Indeed ranking starts early: Being the first to arrive at school, to be on the first team, or to be “in” with the top group in high school. “Rating” persists all through our lives whether it be in selecting starred restaurants, starred videos, or a top brand. Nowhere is it more difficult and important to establish rankings than in economics, and the scandalous misjudgments made by the global rating agencies have led to disastrous consequences, which have not been adequately dealt with.

Whatever group is putting together rankings or ratings, one has to trust their results or they have no meaning at all. That is the question which makes me scratch my head because the top three rating and rated agencies in the US (and the world), Standard and Poor’s, Moody’s, and Fitch all were integral to the greatest economic fraud in history: They handed out top ratings (also known as AAA) to junk bonds which underpinned the real estate market in the United States. This resulted in the economic crisis of 2008, leading to trillions being lost on global financial markets. To date no individual and no company has been fined, jailed, or simply put out of business for this massive and overwhelming fraud. That disturbing lack of a verdict is what prompted me to write this blog entry.

The three principal agencies in question argue in the US courts that their ratings are independent opinions and not statements of fact, and that their legal liability is limited because they have First Amendment protection. The Obama administration has made a conscious and continued effort to avoid criminal prosecution of those responsible at Fitch, Moody’s or S&P but has focused instead on exacting civil penalties from the perpetrators of their criminal acts. The US Justice Department lawsuit for some $5 billion against S&P for issuing ratings that were disastrously off the mark is still under way. S&P will have to prove that their ratings expressed honestly mistaken opinions rather than ones motivated by the desire for higher profits. Most probably there will be settlements of this and other civil lawsuits that are now in process, but nobody will go to jail. More important, no deterrent is likely to result or be established.1

Rating agencies did not exist as businesses until the 20th century. In 1900 John Moody, then only 32 and a Wall Street observer of the tangled and uncertain world of railroad bonds, put together a compendium titled: ”Moody’s Manual in Industrial and Miscellaneous Securities.” This accessible format was such a success that it ultimately launched a new industry. In 1913 Moody’s expanded its service to include a letter-rating system which it borrowed from mercantile credit rating agencies to indicate creditworthiness. His company was also the first to charge modest subscription fees to investors. Poor’s Publishing company followed in 1916, Standard Statistics in 1922 and Fitch Publishing in 1924. All three American agencies provided independent analyses of bond creditworthiness.

The metrics employed by the agencies differed somewhat: ratings by Moody’s reflected what investors might lose in case of default while S&P’s estimated default probability. Of the large agencies, only Moody’s is a publicly held corporation that discloses its financial results. Its high profit margins, which at times have exceeded 50 percent of gross margin, reflect its exceptional pricing powers in this narrowly held industry. Until the 1980s Moody, like its two principal competitors, was principally based in the US, and demand for services was modest because they rated the debt market in an era where companies borrowed mostly from banks, dealing with structures they could understand and individuals they knew. Then, under Reagan and Thatcher, the financial system became less regulated and corporations began to borrow more from the globalized debt markets. As a consequence, evaluations of the credit rating agencies steadily increased in scope and importance as did concern and scrutiny about their reliability and alleged or suspected illegal practices.

In the mid-1990s, after the collapse of the energy firm Enron, both Moody’s and S&P became the target of dozens of lawsuits from investors alleging profound rating inaccuracies. Structured finance also entered the picture with such “financial engineering” marvels as “sub-prime mortgage backed securities” (MBS), collateralized debt obligations (CDO) and “synthetic and squared CDOs” which even most bankers found difficult to price or even to understand. However, these complex structures became increasingly profitable for the rating agencies. By 2006 Moody’s earned close to $900 million in revenue from structured finance. By the time of the crash of 2008, there were over $11 trillion structured finance debt securities outstanding in the US bond market. Of the mortgage backed securities that Moody’s had top-rated with AAA ratings in 2006, three quarters were downgraded to junk just two years later!

Executives from the big three explain that ratings are a simple symbol system to express relative creditworthiness or the risks involved. The rating grades (or relative risks) are usually expressed through a variation of an alphabetical combination of upper and lowercase letters. Generally the agencies have not been as vigilant with those corporations that paid them for high ratings but were aggressive in rating those that did not. The verdict is not yet out whether the ratings produced by the top three in evaluating the collateralized mortgage securities that were given gold-plated endorsements rather than branded as rubbish were the result of negligence or incompetence rather than greed and malpractice.2

Although there are over 150 rating agencies internationally, the two big American credit raters (Moody’s & S&P) control 80% percent of the global market and unbelievably are still the only ones to have high credibility. The big three issued over 97% of the credit ratings in the US, giving them powerful pricing leverage. This brought them profit margins of about 50% in the first decade of this century and levels have not fallen dramatically since then. Partly this is because by US law many investors are permitted only to buy bonds (for pensions and other holdings) that have AAA ratings. Banks, in turn, may adjust their risky investment packages in order to satisfy the rating services. Then bond investors will worry about the very willingness of the rating services to give better ratings in order to encourage banks to issue lower quality bonds. S&P, for example, developed and relied on models which took into account economic assumptions and potential losses in order to come up with inflated ratings. I am describing this spiraling effect only to show the reason I believe the current structure of these ratings groups should be terminated. My conviction is strengthened by the fact that these agencies also advise their corporate customers where best to domicile their headquarters and how best to circumvent national laws and avoid governmental taxation.

In the United States in 2010, in reaction to the disastrous impact of S&P and Moody’s ratings on the global economy, the Congress passed the Dodd-Frank Act which called for federal officials to review and modify existing regulations in order to avoid the reliance on credit ratings as the principal assessors of creditworthiness.

In an attempt to rescue its fallen standing, S&P took the unprecedented step in 2011 of downgrading the AAA ratings of US government bonds because of Washington’s inability to get its financials in order — as evidenced by the fiscal cliff on which it had then been balancing. The Secretary of the Treasury countered by saying that S&P had “shown a stunning lack of knowledge about basic US fiscal math.” He also pointed out that S&P’s sovereign debt team miscalculated the US debt by nearly $2trillion! When the Justice Department then asked for $5 billion in 2013 to recover losses it said federally insured institutions suffered as a result of these faulty ratings, S&P dramatically replied that the US government was only trying to retaliate for its downgrade. The courts may eventually rule that there is a conflict of interest for the Treasury to penalize S&P for having given a fair rating against its own interests.3 In the meantime S&P continues to offer underwriters more desirable bond ratings than their competitors in order to get their business.

“Sometimes it is hard to dismiss the impression that some American rating agencies and fund managers are working against the Eurozone,” said the former German economics minister Rainer Bruederle.4 In January 2012, amidst continued economic instability, S&P had downgraded nine European countries including the AAA ratings of France and Austria. In November 2013 S&P went further and cut down France’s rating from AA+ to AA, expressing doubts over France’s ability to restore growth. Economists like Paul Krugman viewed this further downgrade as politically motivated. France was raising taxes and rejecting austerity and this went against the right wing position that spending on benefits, health and social security should all be cut as well as taxes. S&P had been eager to demonstrate that its ratings were tough and principled in order to counter-act all the damaging publicity it had received for its role in the global crash.5

The potential for downgrades to destabilize member countries became so strong this year that the European Parliament agreed to a set of rules designed to slowly rein in S&P and Moody’s as well as the smaller rating agencies. The Brussels parliamentarians also wanted to encourage financial firms and others to do their own credit assessments. In the US, The Securities and Exchange Commission has had trouble hiring inspectors who will ensure that those who determine the ratings are not involved in marketing the services of their agency.

So we must ask, does a globalized world with many fragile and unstable economies really need such fundamentally implausible rating agencies as S&P and Moody’s? Managed by greedy fortune-tellers, these agencies have been seen to intimidate politicians, corrupt the markets, and destabilize national economies. New rules and regulations are not the answer. The response so far has been that the rating groups, aided by lobbyists, simply devise new ways to avoid any new rules and run in circles around the bureaucrats hired to monitor behavior.6

As the rating agencies have lost the confidence of the business community, I suggest that the time is ripe to create an over-arching international and inter-governmental agency to rate not only bonds and corporations but also sovereign debts. Such a public agency staffed by economists and administrators from the IMF, World Bank, the OECD and the United Nations could report to the G-20. Predicting uncertainty can never be perfect, but it would be far better for all the people and nations of this world if the giant ratings cartel was operated as a non-profit, public service. Perhaps it would be an organization in which bureaucratic boredom would prevail, as in many UN agencies, and where no one would be particularly concerned about the ratings it could routinely produce.

1Floyd Norris, “Stumbling over audits and ratings,” The New York Times International, August 22, 20142Sam Jones, ”When junk was gold,” Financial Times (Weekend),October 19, 20083Nathaniel Popper, “S&P’s rating habits,” The New York Times International, August 2, 2013, p.24Patrick Kingsley, “Making the Grade,” The Guardian, February 16, 20125Paul Krugman, “The plot against France,” The New York Times, November 12, 2013.6Donald J. Johnston, “An alternative to the ratings agencies,” The New York Times, February 12, 2013